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Absorption, Variable, And Throughput Costing
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Absorption, Variable, And Throughput Costing
Absorption, variable, and throughput costing are three managerial accounting approaches
used to distribute costs for goods or services. The absorption or full costing is when all the direct
and indirect manufacturing costs are divided into the units produced. (Al-Qahtani et al. , 2021).
The list of expenses related to the production process comprises direct materials, direct labor,
variable overhead, and fixed overhead costs. It views the fixed manufacturing overhead as a
product cost and then applies the decision to add it to the inventory value until the products are
sold. Absorption costing is usually the first one for external financial reporting under the
Generally Accepted Accounting Principles (GAAP). Thus, we can know the exact cost of the
product.
On the other hand, variable costing is the opposite of traditional costing in that it assigns
only the variable manufacturing costs (direct materials, direct labor, and variable overhead) to
the products. Manufacturing overhead costs unrelated to the production process are considered
fixed-period expenses and are not a part of the inventory cost (Kadir et al., 2020). Variable
costing is the approach that concentrates on the costs directly linked to the production volume,
making the contribution margin per unit more apparent and, thus, helps in making decisions such
as pricing and product mix. As opposed to absorption costing, variable costing is usually a true
reflection of the costs incurred during changing production levels. Thus, it is a good tool for
internal management.
Throughput costing, is a method that considers only the direct materials costs as the
product costs. Direct labor and overhead costs are considered period expenses and are incurred
simultaneously. Throughput costing is based on the theory of constraints (TOC), the system of
production processes that identifies the bottlenecks and aims to maximize the throughput or the
rate at which a system generates money through sales. Throughput costing is the method of
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calculating the cost of production, which is based on the direct materials used in making the
product (ElMaraghy & Alami, 2020). This way, the companies can concentrate on making their
processes more efficient, the inventory levels can be reduced, and the demand can increase
production. It is, in particular, beneficial in situations where the production capacity is limited or
confined by the availability of certain resources.
The decision to choose between absorption, variable, and throughput costing is based on
the goals of the analysis and the type of activities in the business. Absorption costing is usually
applied as the method of external financial reporting used to meet accounting standards (Al-
Qahtani et al., 2021). Variable costing is a good tool for internal decision-making, particularly in
the cases of production levels that are not constant, as it gives the true cost behavior. Throughput
costing is the best when throughput is the priority, such as manufacturing plants with low
capacity or industries with high demand variability.
An example of this is a manufacturing company making widgets. If the company intends
to convey its financial performance to external stakeholders, vision costing will determine the
cost of goods sold and inventory valuation. On the other hand, if the company is examining the
profitability of the products to make price decisions, it might choose variable costing to
concentrate on the variable costs per unit (Kadir et al., 2020). Meanwhile, if the company
implements TOC principles to enhance production efficiency, it can use throughput costing to
find and eliminate bottlenecks in the production process; thus, the throughput and profit will be
maximized.
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References
Al-Qahtani, A., Parkinson, B., Hellgardt, K., Shah, N., & Guillen-Gosalbez, G. (2021).
Uncovering the true cost of hydrogen production routes using life cycle monetisation.
Applied Energy, 281, 115958. [Link]
ElMaraghy, W., & Alami, D. (2020). Activity based aggregate job costing model for
reconfigurable manufacturing systems. International Journal of Industry and Sustainable
Development, 1(2), 1–19. [Link]
Kadir, A. Z. A., Yusof, Y., & Wahab, M. S. (2020). Additive manufacturing cost estimation
models—a classification review. The International Journal of Advanced Manufacturing
Technology, 107(9-10), 4033–4053. [Link]